Proposed legislation that would allow bankruptcy judges to modify primary residence mortgages would create a level of uncertainty of U.S. residential mortgage-backed securities (RMBS), according to a recent report by Fitch Ratings.

The so-called mortgage “cramdown” proposal has hit staunch opposition from the mortgage industry, but is being hailed as a move to help consumers in danger of losing their homes by supporters.

According to the report, “While there are still many unknowns to be determined before U.S. RMBS market participants can gauge the effect of proposed bankruptcy cramdown legislation on outstanding transactions, passage of such provisions are not likely to trigger immediate rating downgrades of transactions.”

The report said variables including the final language of the legislation, how any new laws would affect the pace and degree of loan modifications or what type of increased incentive it would provide for borrowers to declare bankruptcy would all have an impact on how it rates securities.

Huxley Somerville, group managing director and U.S. RMBS group head at Fitch, said, “While immediate wholesale downgrades are unlikely, Fitch will monitor its rated transactions for cramdown losses and take rating actions when there appears to be risk of significant loss. Due to varying deal language, about 31 percent of Fitch rated Prime and Alt-A transactions have a greater risk of senior bond downgrades with the remaining 69 percent having limited risk.”

Both houses of Congress have versions of the Helping Families Save Their Homes in Bankruptcy Act and they are making their way through the legislature. The Obama administration has signaled it would like to see a cramdown bill come as an individual item, and not attached to other legislation, like the pending economic stimulus package.

Leading the fight against cramdown legislation is the Mortgage Bankers Association (MBA). The organization said it doesn't support the proposal, but if a law is passed, it should include provisions that limit judges' ability to modify mortgages only after an attempt at modification has been made and set a limit to how much the loan can be modified. The MBA also wants the law to include profit-sharing of a home's future appreciation between lenders and homeowners as well as a sunset day.

Steve O'Connor, the MBA SVP for government affairs, said, “The bottom line remains that bankruptcy cramdown would help a small number at the expense of everybody else,” said. “It's not the solution and would actually step back the market.”

Austin Kilgore | 01.29.09 www.dsnews.com